Preparing to invest USD1 billion for minority stake in Delta/Northwest;

Ready to inject EUR3 billion into Alitalia – seeks 100% ownership;

Expected to be bid for CSA-Czech Airlines;

In close negotiations for investments with (and possibly in) China Southern Airlines;

Malaysia Airlines stake could come on the market;

Virgin Blue’s majority shareholder looking for a buyer.

Crude oil prices closed overnight in New York above USD100 per barrel for the first time. It has also broken through the psychologically important barrier for the first time since early Jan-08, on heightened supply fears. Traders are concerned OPEC may reduce output next month to support prices in a USD85 to USD100 per barrel range.

Furthermore, oil for delivery in December 2015 set a record high last week of USD92.50. When oil for immediate delivery reached USD100 per barrel for the first time during intra-day trade on 02-Jan-08, the 2015 delivery price stood at USD88.33 – reflecting market expectations that there is unlikely to be any relief from high oil prices for years.

Record oil prices are occurring despite a US economic slowdown, which is creating the conditions for a 'perfect storm' for the airline industry.

But amid the turmoil lies an opportunity for a new industry structure, based on closer equity arrangements. Air France-KLM is aiming to be at the heart of this shift.

The world’s biggest airline group by revenue (since the Air Francemerger with KLM in 2004) is preparing to invest USD1 billion to acquire a minority stake in the planned merger of Delta Air Lines and Northwest Airlines. Such an alliance would make it the largest carrier on the North Atlantic, holding approximately one third of the market. Northwest would add extra strength to the trans-Atlantic revenue and cost-sharing JV already planned between Delta and Air France-KLM.

At the same time, Air France-KLM is ready to inject EUR3 billion into Alitalia over the next six years and wants to eventually acquire 100% of the Italian carrier. But its European ambitions don’t stop there. Air France-KLM is expected to be a key bidder in the privatisation of SkyTeam Alliance partner, CSA-Czech Airlines later this year.

In Asia, Air France-KLM is already in exclusive negotiations to establish a JV cargo operation with the newest SkyTeam member, China Southern Airlines. An Air France unit also last month took over the Chinese airline’s catering unit, signaling cooperation is progressing well.

China Southern, a global top-ten carrier by passenger numbers and which recently stated it is seeking a partner to help improve the competitiveness of its passenger business, could eventually seek an equity arrangement with the European major. Timing could be influenced by the speed of the outcome of the China Eastern Airlines tussle between Air China/Cathay Pacific and Singapore Airlines.

Elsewhere, a stake in Malaysia Airlines (MAS) could come on the market soon, according to CEO, Idris Jala. The reformed Malaysian carrier is a much more attractive alliance proposition than when SkyTeam previously held talks with MAS.

In Australia, Virgin Blue’s majority shareholder is looking for a buyer. The “new world carrier” will soon have a long-haul airline subsidiary linking Australia to the US and North Asia, to go with its extensive domestic and regional Australian network, New Zealand and Polynesian operations.

A global airline group, linked under common Air France-KLM equity ownership, is a distinct possibility within the next few years.

The first step – a Delta/Northwest union, with Air France-KLM backing – could wreak havoc on the global alliances structure, as a cross-alliance pairing between United Airlines and Continental or American would be almost inevitable. Such dislocation could play into Air France-KLM’s hands.

Meanwhile, soaring fuel prices, an economic downturn and associated pressure on airline earnings (and valuations) could lower the overall cost of acquiring such a global position.

Such a development would re-write the global aviation structure. The cashed-up Air France-KLM is in the driver’s seat.

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Pilot strikes at Lufthansa. Again. A strike ballot among British Airways cabin crew. A guilty verdict for Air France workers who assaulted an executive during a union protest. These were all headlines in late Nov-2016, following Air France pilot and cabin crew strikes in summer 2016. Labour relations at Europe's three biggest legacy airline groups are an ongoing challenge.

A CAPA report in Jun-2016 highlighted the growing number of articles on CAPA's website mentioning the word 'strike'. It raised the possibility that if the rate continued through the year, 2016 could be the biggest year for strike-related articles since before the global financial crisis. With a little under a month still to go, this year has already comfortably passed this milestone.

To a large extent labour unrest grows as airline industry profits increase. However, rather than hoping for an industry downturn to reverse the rise in the cycle of strikes, airline CEOs are talking tough – a line long taken by IAG's Willie Walsh. Lufthansa's Carsten Spohr has said that taking on the pilots is "about the future of Lufthansa", noting that it has “no chance of survival" if it gives in to pay demands (Bloomberg, 24-Nov-2016).

Air France-KLM, Lufthansa Group and IAG collectively reported a fall in operating profit and operating margin in 3Q2016, after growth in 1H2016. Individually, only IAG avoided a decline in its operating margin. IAG also remained the most profitable, and Air France-KLM the least profitable, in the most important quarter of the year.

The margin contraction in 3Q resulted from a bigger fall in unit revenue relative to 1H, without a matching fall in unit cost (in spite of lower fuel prices). Passenger unit revenue fell by 6% to 7% for all three (adjusted for currency movements), with long haul markets especially weak. Unit revenue was particularly soft on routes to Asia Pacific and on the North Atlantic (and, for Lufthansa Group) on the South Atlantic.

The combined operating margin of the three has been a good indicator for European airlines overall in the past. The outlook for FY2016 for each still suggests that there will be margin improvement for the year as a whole. This could be in line with, or slightly above, the cyclical peak reached in 2007 – before the global financial crisis. Against this backdrop, the decline in margin in 3Q2016 suggests that further improvement may be difficult in 2017.